General

Market developments

2015 was an important year in energy and climate worldwide. After having recorded the warmest year since measurements started, 2015 beat the record set only the year before with a historic margin of 0.13 degrees Celsius. Most of the warming has occurred in the past 35 years, with 15 of the 16 warmest years on record having occurred since 2001. NASA notes that 2015 was influenced by El Nino, but nevertheless it is the latest in a record-setting trend since 20011. Similar observations can be read in the findings of the World Meteorological Organisation2.

The awareness about the possible consequences of rising temperatures increased in the course of 2015, with the Climate Conference in Paris in November 2015 taking an important role in this respect. The concluding treaty, signed on December 12, ended the earlier differentiation between developed and developing countries. Instead, a common framework was introduced, committing all countries to put forward their best efforts. For the first time parties are required to report regularly on their CO2 emissions and implementation efforts, subject to international review.

The attention for climate change in 2015 and the outcome of the Climate Conference can be expected to trigger acceleration in investment opportunities in renewable energy, as governments develop policies to adhere to the commitments they made in Paris. As the contribution of renewable energy grows throughout Europe and proven technologies become increasingly competitive with fossil fuel generators, governments are revisiting the support mechanisms from which renewables benefit. In this evolving landscape of support for renewables, the fund’s role as an experienced and reliable financial partner becomes increasingly important to developers of small- to medium-sized renewable energy projects.

Triodos Renewables Europe Fund will continue to focus on opportunities in areas with relative modest support programs, demonstrating the sustainability of the projects by employing proven technologies. The declining capital costs of proven renewable energy technologies continue to improve the competitiveness of renewably generated power. The fund therefore sees justification for lowering the dependency on regulatory support mechanisms in the sector and thus for increasing the sustainability of the energy system.

Regulatory support mechanisms make up a substantial part of the fund’s revenues. It is the fund’s view that the regulatory support, for which the projects in the portfolio have already qualified, will remain stable in the coming 20 years. Early 2015, we have seen a reduction in the long-term projection of European electricity prices. This has been driven by the drop in global oil prices and a proposed regulatory change in many European countries. Later in the year the price forecast recovered, fuelled by higher expected coal prices in the long term and a stronger US dollar. Both these changes have been considered in the long-term price projections upon which the fund’s value is calculated.

Approximately half of the European electricity is generated using oil, natural gas and coal, the cost of which all strongly correlate to global oil prices. Wholesale electricity prices have only relatively modestly decreased in 2015, while oil prices dropped by 39%3. This difference is largely driven by the way electricity generators purchase their fuels (combining both long-term and short-term delivery). If the slump in oil prices persists for an extended period, however, we may expect further (downward) impact on European electricity prices.

The second driver of future electricity prices is the introduction of new EU energy market regulatory regimes. These new regimes will affect wholesale electricity market prices in several European markets. The so-called capacity market mechanisms will provide supplemental income for fossil fuelled power producers to ensure security of supply. This supplemental income will allow them to bid into the wholesale market at a lower level, thus lowering the prices in the wholesale market. The capacity market mechanisms are part of a package of measures aimed at supporting the continued proliferation of renewable energy projects.

The renewable energy projects in the fund’s portfolio sell electricity and therefore have exposure to the wholesale market. The fund mitigates its exposure to price volatility in the wholesale electricity markets by a range of measures, including deriving revenue from regulatory support and power sales agreements incorporating fixed prices. Through its geographic diversification the fund also reduces the exposure to energy prices, as each country has a different power price sensitivity and support schemes for renewable energy. As a result, changes in the long-term energy price outlook only had a moderate impact on the portfolio’s value.

The countries where the fund has investments (see (PDF:) chart) have ratings varying from BBB+ to AAA. With the exception of Spain, all countries have a rating of AA or higher. The reduction in the level of support mechanisms for new projects is also in line with the objective of the fund, being a demonstration of sustainability with lower capital expenditures per MWh required. Especially in solar projects the continued downward trend in construction costs, mainly due to declining solar module costs, is considered a positive sign of the improved profitability of renewable energy projects, meaning a lower dependency on government support. It is therefore expected that most projects in the portfolio will continue to perform in line with the fund’s long-term target return.